I recently received an email that posed an interesting scenario in Chapter 7 bankruptcy liquidation.  Although I have written on the subject of Chapter 7 liquidation I haven’t addressed the specific fact pattern in detail.  This post fills that lacuna.

The question posed was a bit long, so I will summarize it.  The questioner asked whether a sufficiently large tax lien on a debtor’s principal residence would dissuade a Chapter 7 Trustee from seizing and liquidating the house.  My answer not only deals with the question posed, it also includes a discussion of the exemption implications as well.

The analysis depends primarily on 724(a), 726(a)(4), and 11 U.S.C. §§ 551.  Based on these Code sections, the tax lien has two potentially negative implications to the case.

I.  The Trustee Can Avoid The Tax Lien To Create Equity For The Estate

A.  The Taxing Authority Will Release The Lien

If there appears to be no realizable equity solely because of a tax lien, the Trustee is free to ask the taxing authority ― whether the IRS, or the FTB, or both ― to release the lien to create realizable equity for the bankruptcy estate.  A taxing authority is willing to release a lien in this context because upon liquidation of the asset, its priority tax claim will be paid ahead of the general unsecured debt ― meaning that the taxing authority will get money right away rather than having to wait for the debtor to sell or refinance the property.  In addition, after the Court grants the debtor a discharge, the taxing authority will still have a claim against the debtor for the unpaid, nondischargeable portion of the tax debt.  Thus, from the taxing authority’s perspective, there is no down side to releasing the lien.
Continue Reading Liquidation Of An Asset In A Chapter 7 Bankruptcy II